Powell's speech leaves the outlook for Fed policy uncertain and highly data-dependent. Markets are pricing in around a 50-50 chance of the Fed delivering one additional 25-basis-point rate hike by November, which is reasonable in our view.
Powell noted the progress made on inflation so far, which he sees driven both by normalization of economic conditions following the pandemic and the Fed's policy tightening. However, he also stated that "the process still has a long way to go," and reiterated the Fed's willingness to raise rates further if needed to bring inflation down to their 2% target. Importantly, Powell sees the current level of interest rates as restrictive, which suggests that inflation will eventually hit the target if they simply leave policy unchanged.
Another key point from Powell's speech is that "getting inflation sustainably back down to 2 percent is expected to require a period of below-trend economic growth as well as some softening in labor market conditions." GDP growth has been above-trend since 3Q22, and the Atlanta Fed's GDPNow tracking estimate for the current quarter (3Q23) stands at a sky-high 5.9%. While we think GDPNow will come down as more data becomes available, it still appears that the needed period of below-trend economic growth hasn't even started yet. This suggests that the Fed is unlikely to cut rates anytime soon unless there is a dramatic weakening in the data.
Several key economic indicators will be released this week. The labor report for August has great potential to move markets. In addition to the headline nonfarm payrolls figure, measures of labor market tightness such as average hourly earnings and the unemployment rate are also important. We expect JOLTS job openings to remain on a downward trend, but this data has been very noisy month-to-month. The report on personal income and spending for July will also be critical. The data will affect estimates of the amount of excess savings remaining, and also includes the PCE deflator, which is the Fed's preferred inflation measure. As noted in today's speech, Powell puts emphasis on core service prices excluding shelter as a key measure of underlying inflation. In our view, this measure is likely to show a relatively strong increase, supporting the argument for another rate hike.
Main contributor - Brian Rose
Original report - Powell speech covers familiar ground, 25 August 2023.